Pretend for a moment that you’re preparing to go to work. You’ve completed your morning routine and are just a few moments away from departing for the office but this particular morning is a little different. You have the means to get yourself to the office but not to return home. You hear the conversation run through your mind: “How are you going to get home? You don’t have access to public transportation. You don’t have money for a taxi. Your coworkers are not able to bring you back. There are no friends or acquaintances that can pick you up. You have no money and just enough gas to get you there. What in the world are you going to do?”

Would you even travel to the grocery store without the ability to return home? How about a vacation, would you plan a trip without specific knowledge of your return?

Plan my descent down Mt. Everest? No, I’ll just wing it

The answer is simple to these somewhat rhetorical questions; however, I wonder if those who set out to climb Mount Everest spent any time developing a plan to get them off the mountain? I would be willing to place a wager that not one single expedition up Mount Everest, let alone any mountain, has ever failed to plan a way back down. Not once. Why? Because summiting the mountain is only half of the journey. Unfortunately, the descent down Mount Everest is the most dangerous.

In a story from Scientific American back in December 2008, 56% of those who have died on Everest have died during their descent after summiting. Another 17% died after turning back (i.e. descending). That’s a total of 73%. Only 15% died on their way up or before leaving their final camp. The remaining died through various accidents like avalanches and falling ice at lower altitudes.

The descent is by far the very most dangerous, treacherous, threatening, unsafe, formidable, perilous and risky phase of the Everest exhibition. If there is no plan in place for the descent then failure surely awaits.

Retirement is just like descending the mountain

How does this real life example perfectly reflect the financial planning being pursued by virtually 68% of the population (Figure 7.5 http://www.icifactbook.org/fb_ch7.html)? The answer is simple: pre-tax investments. You’ll notice that the Figure 7.5 is titled “Many U.S. Households Have Tax-Advantaged Retirement Savings”. Wow, is that ever misleading. Pre-tax investments are not in any way tax-advantaged. What is the advantage? Many financial pornographers, like Dave Ramsey, profess that there is a mathematical advantage to investing pre-tax. Math proves him wrong. A couple of years ago I wrote a blog on this very topic so I won’t duplicate it here. So if you think I’m wrong then read this post first…and then feel free to comment.

How does Mount Everest tie into this tax debacle for the everyday American? Well, if you have money in an IRA, 401k, SEPP, or another government-run retirement plan (even Roth IRAs) then you have an enormous tax problem. You see, you are climbing the mountain with no knowledge of how to get down the mountain. What are the tax laws when you decide to retire? What are the distribution requirements? What are the tax rates? Do you know? Does anybody?

Only the financial planner with a crystal ball

There is not one single financial planner on the planet that can plan a retirement (using assets to provide income in order to maintain a desired lifestyle) for an individual when the majority of their portfolio is made up of government-run plans. The professional certainly doesn’t know the answers to the above questions and therefore has no idea how long the money will last. How much is the government going to take? If you have an IRA or any other pre-tax vehicle (the balance is irrelevant) then I have one question for you: how much of it is yours? No one knows. And no one will know until you’re standing on top of the mountain…and at that point you’ll only know one year at a time. It’s just like climbing Mount Everest with no plan to descend until you’re finally standing on top…very dangerous strategy. It’s actually worse than that because are the rules going to be the same when you’re 75 as they were when you started using the funds at age 65? It’s like only being able to plan your descent every 10 feet and having no idea what’s facing you at the next 10 feet. That’s not just dangerous but perilous.

Kelly, I’ll be in a lower tax bracket. You will? How? Why does the government put far more restrictions on after-tax positions (Roth IRA) – like income and contribution limits – than they do on the pre-tax (no income limitations and you can contribute a heck of a lot more). Seriously, why? Because they know that the only mathematical factor that determines the winner is the future tax rate and only they control that factor. You don’t control it otherwise your taxes would be zero. Roths aren’t even safe because they can change the rules at any point. Could they choose to tax the gains? Yep. Social Security was supposed to be tax-free forever but that changed.

The government is absolutely working in my favor…or is it?

Do you believe the government has your best interests at heart? Do you honestly believe that they are fine with you not paying taxes now so that you can pay less in the future? Do you feel the government will do everything it can to ensure the math lines up in your favor so you can get down the mountain? Me neither. Yet almost 70% of households are doing this very thing and unfortunately, virtually all of them will face a “tax descent” that will be immensely costly. Here’s a video that goes into some detail on this issue.

When did all this begin in the first place? Could that give us any insight? It sure can. Pension plans worked very well so why did all of that change in the 1980s when the government realized it had the largest working population in all of history (American history)? Why did pension plans fall out of favor to be replaced by the government-run retirement accounts? Who had lobbyists in that room?

Certainly the government was in that room because they could then control the largest portion of the citizens’ retirement assets. There’s an estimated $19,000,000,000,000 held in these accounts. That’s $19 trillion controlled, not by the citizens, but the government. The banking industry was certainly present in the lobbying for this because the rules with these accounts do not favor the investor having access to capital. Penalties, unfavorable loan features and simply the denial of access to the funds in these accounts (can’t access more than the loan provisions on a 401k while employed with the company – why?) mean that the investor will need the bank. Wall Street was also at the table because this would put the once untouchable pension now in the hands of the investment broker. It also would provide incredible job security for Wall Street because the investor can’t touch the money until they’re 59 ½ years old. If you’re 25 years old and contributing to a 401k then that represents 34 years of security for Wall Street. That’s awesome for them.

Turn the coin over. Look at the other side. Follow the history. Dig in. Let the light shine on this a little bit and you’ll realize that NONE of it is for your benefit. None.

There are solutions but you must be willing to have some conversations. You must be willing to plan a descent and not just for the summit! Our job is to ensure you get DOWN the mountain because, after all, that’s the goal.

I can’t believe it has been almost four years since my first “how financial institutions make money” post. Crazy how fast things go by so quickly. This initial post continues to be one of my most active even today and the primary path that people come to this post is through Google. It’s interesting that so many people are simply Googling (love that this is now a verb) the question: How do financial institutions make money? Honestly, I believe many people are pretty fed up with how things have been going financially and yet the Big Three (IRS, Wall Street, Banks) keep making money hand-over-fist.

For the most part, people are finally seeking to educate themselves first before just following another opinion. Opinions drive me crazy. I’m mean, I certainly like mine but who cares other than me, right? Mint Chocolate Chip is the BEST ice cream flavor of all time. No Kelly, says you, “_____ is the best ice cream flavor!” Who’s right? Who cares? Seriously, no matter what you say I still love Mint Chocolate Chip.

When it comes to the title of this blog “How financial institutions make money” there are no opinions. There’s only truth and the truth could care less about opinions. All of us must understand that there are four rules which are deeply cherished by the IRS, Wall Street and Banks. These rules allow all three to work together. They allow all three to ensure that they’re winning. They allow all three to redirect the risk of success entirely upon you. I thought we’d review these four rules today. You’ll find that they are extremely simple but they have huge implications. It’s interesting to me that even the Bible talks of a cord of three strands being unbreakable…these three (IRS, Wall Street and Banks – from now on referred to as “IWB”) are most certainly intertwined together and are so hard, if not impossible, to break.

Rule #1: They want and need your money

Now, before you pass this one off as too simple to carry any weight then please take a moment to think about the importance of this one (it’s #1 for a reason). This one does not require much explanation. All three, IWB, want our money and need our money in order to both operate and turn a profit.

Rule #2: They want and need your money on an ongoing basis

What would happen to Walmart, Coca Cola, Pepsi, McDonalds, Budweiser or any other company in the country if beginning today every customer only bought their product(s) one more time? That’s it. Just one more purchase. They would obviously have a HUGE day if every customer placed their order today but come tomorrow the alarms would be blaring. Nobody shows up again and these businesses are out of business very quickly. Think of all of the employees that would be unemployed or all the buildings that would be vacant or all the farmers who would have no one to sell their produce to…the results would be devastating and felt by all.

Is this example any different for the IWB? No. They must have your money and they must have it on an ongoing basis. If they don’t succeed at this very simple truth then they fail as well. Now, we could dig in real deep to show how, unlike the above mentioned companies, it is virtually impossible for them to fail. They can’t. They won’t. If they actually do fail then along comes Joe Taxpayer to bail them out so that they don’t fail. No matter what happens, they get our money on an ongoing basis.

So how do they accomplish Rule #2? They create financial products that we buy and that we “need”. Banks offer checking and savings accounts, CDs, money markets, loans, credit cards, etc. Wall Street offers financial investment accounts that we contribute to and hopefully grow and the IRS controls the tax implications and the rules behind all of it.

Rule #3: They want and need to hang on to your money for as long as they can

Does the bank like it when you withdraw your money? Of course they don’t. Keep in mind; their liabilities are their greatest assets. Your money on deposit with them is a liability to the bank – they owe you that money at a promised interest rate; however, they’re turning that money over and lending it to others at a higher rate. We must understand that there is a difference between liabilities and debt. Debt is no good and we must get rid of it but liabilities when managed properly can create a bunch of wealth for us just as they do for the banks. What happens if everyone goes to the bank the same day to withdraw their funds? It’s called a “run on the bank” and the bank would have to shut their doors or be faced with bankruptcy. They are never in a position to get everyone their deposits back on any given day because they don’t have it. They need our money, they need it on an ongoing basis and they need to hold on to it as long as possible.

The government is the worse with Rule #3. Why do they have so many rules when it comes to you using (whether you simply need it or just want it) your funds in your qualified plan accounts (IRAs, Roths, 401ks, etc.)? First, let’s make sure we get something very clear here – any funds in your government, qualified plans are not your funds. The government owns and controls that entire transaction. If it is truly your money then why are there so many rules around accessing the funds? Why do you have to wait until you’re 59 ½ to touch it without penalty? What if you choose to retire at age 50? If these accounts are truly in your best interest then why is there any penalty at all? Why are you required to take money out if you hit 70 ½ (Required Minimum Distribution)? What if it doesn’t fit your plan or it’s not in your best interest to access those funds at that point? The number of rules and regulations on these accounts are insane. You have NO control over them ultimately. Plus, the government can change the rules at any point to serve their financial needs. So, the IRS loves Rule #3. The banks love it as well. Wall Street makes a killing off of it too because they get to manage the money within these products. Think about it: you’re 35 years old with an IRA and you can’t touch it without penalty for 24 more years! Wall Street has a client for a LONG time!

They want to hang on to your money as long as they can and the rules and the product design allow them to do so.

Rule #4: They want and need to give your money back to you as slowly as possible

This one is similar to Rule #3 but it has a slight twist. They want to hold on to our money for as long as possible therefore they create rules to give it back to us as slowly as possible. If this isn’t the case then please explain the 10% tax penalty for withdrawing funds from a qualified plan retirement account prior to being 59 ½ years old. It’s your money (after all, you’re the one who made the deposits) so why are there so many rules and why are there penalties for you if you choose to access your funds? Answer: Rule #4. The government does not want you to be in a position of control because that takes away from their control so they create rules. These rules are based around them maintaining control so they limit your access. What’s shocking is that people continue to fund these accounts. Wall Street loves it because it creates a great deal of job security because they know you won’t access this money due to the rules and penalties so they have your money under management for many many years. The banks love it too because you’re not in a position to access capital for large capital purchases so they offer you a loan…and we know how much banks love that one.

These four rules are always at the center. When you begin to plan your trek up the mountain of retirement planning you can always find these four rules working against you…if you just pay attention.

Mt. Everest – descending is the most dangerous

Are there options? Are there ways to minimize the effect of these four and create a more effective plan up the mountain? Yes there are. Remember, for those who die climbing Mt. Everest, 70% of them die on the way down. The descent is the very most dangerous part of that journey. It’s no different financially. People are just climbing up without an understanding of how these rules affect them and more importantly, how they affect them on the way down. What do I mean by that statement? Well, if you have a large sum in your qualified retirement account, or that’s your plan at least, then please tell me the tax implications on that money during your retirement? You don’t know. No one does…it’s impossible because you’d have to literally know the future. You see, any financial professional can only plan one year at a time with those types of accounts because we don’t even know what taxes will be or what the distribution rules will be for next year. If you’re in this position then you can truly only plan one year at a time and that’s a very dangerous position to be in. The descent will most likely not work out in your favor. You must not only plan to effectively get up the mountain top but also to get back down to base camp alive (i.e. be financially independent through your life expectancy). With this knowledge your trek up the mountain may take a different path and while others are falling off you’re holding on just fine. That’s our expertise. That’s what we do for our clients.

There are solutions. There are answers to minimize the Four Rules’ overall negative effect on your plan; however, you have to be willing to learn. I don’t care what financial position you’re in, you must be willing to have a few discussions with a student-type mentality.

In November of 2009, I wrote a blog post titled: Why “the experts” confuse the average investor (here is the link). This topic popped into my mind the other day as I was talking with my 10-year old daughter. She asked me the classic question: “Daddy, why did the chicken cross the road?” Of course I knew that a rip-roaring joke was about to be laid out on the table…at least that’s how I had to portray it with her. Sure enough, she had a great answer and I busted out laughing. This got me thinking about my previously mentioned blog post because the answers to the question posed by my daughter are endless and they simply depend on who’s answering the question.

I thought, what if we asked this simple question about the chicken to various people, maybe even historical people? Would their answers have been the same or would they be different? So, here we go, “Why did the chicken cross the road?”

Their answers*

Dr. Seuss: Did the chicken cross the road? Did he cross it with a toad? Yes! The chicken crossed the road, but why it crossed it, I’ve not been told!

Ernest Hemingway: To die. In the rain.

Buddha: If you ask this question, you deny your own chicken nature.

Martin Luther King, Jr.: I envision a world where all chickens will be free to cross roads without having their motives called into question.

Colonel Sanders: I missed one?

Attorney: Chickens are invited to cross the road to join a class action lawsuit against all non-chickens.

Bill Clinton: I did not cross the road with THAT chicken. What do you mean by chicken? Could you define ‘chicken’ please?

George Bush Sr.: Read my lips, no new chickens will cross the road.

Retired truck driver: To prove to the armadillo that it could be done.

Albert Einstein: Did the chicken really cross the road, or did the road move beneath the chicken?

This is all in fun of course but the theme here is very similar to the variety of instructions given to people about solidifying their financial future. Having a clear understanding and a concise plan can be almost impossible because financial professionals virtually always disagree with each other and they never provide the same answer. Most people have heard the following conversation over and over again whenever they speak with a new financial expert: “How much money do you have? Where is it? Oh my gosh, why did they put you there!? You need to come over here because we’ll do so much better.”

Climbing Mount Everest

So, who can you trust? Who really has your best interests at heart? This is often the hardest hurdle to get past. This reminds me of climbing expeditions up Mount Everest. What is the most important phase of the climb? This single phase is responsible for over 75% of all deaths that occur during the quest to summit Everest. It’s the descent. The plan DOWN is the MOST important part of the entire expedition.

Financially it’s no different. The “climb” to the summit can be viewed as the accumulation phase as you work towards your retirement. The descent is the distribution phase of your assets to ensure you have enough money to live on for as long as you’ve planned to live. What does traditional planning focus on the most: i) simply getting to the summit or ii) getting to the summit with a very specific plan on how to get down? ING put out a series of TV commercials (here’s one of them) asking you if you “know your number”. That “number” is the amount you need to retire or more specifically the number you need TO GET TO THE TOP OF THE MOUNTAIN! But ING, what is the plan once that number is reached? Our focus should be even more intent on that phase of life than any other.

105% increase in 10 years!

Truly, if you hired a guide for your climb up the mountain and you asked him for his plan to get you down the mountain, how would you feel if he said this: “I don’t know, but once we get there we’ll figure it out.” Remember, 75% of those who die, die on the way down. Look around, how are people doing? We have an aging population, a declining workforce, an inability to save, a national debt that’s beyond comprehension and a government whose only answer is to print more money. According to whitehouse.gov (Table S5 Proposed Budget by Category) if we wiped out the entire Federal Government and the entire Military (all discretionary spending for 2012) then we’d still be short by $8,000,000,000 due to the various entitlement programs (we did a video on this very topic). Let that sink in, the ENTIRE federal government and the ENTIRE military and we’d still be short. Now, if you do this exact calculation for 2013 then we’d have a surplus of $360 billion (again, only if we got rid of the federal government and the military – obviously never going to happen) but look at the “total receipts” (all taxes collected)…they’re predicted to go up by 17.5%! If you look at the total receipts predicted in just 10 years, 2022, it’s a 105% increase from 2012. Are you ready for that? What’s your plan to deal with this issue? How are going to get down the mountain? If you’re only being told that you’ll be in a lower tax bracket in the future then you better get a new climbing guide.

Reduce future taxable income

There’s an endless amount of Congressional Budget Office reports and Government Accountability Office reports informing you that your taxes are going up plus the dollar will continue to weaken (the hidden tax). How will all of this affect you once you decide to “come off the mountain top”? Please understand, there are strategies and solutions to help mitigate some of these issues but you must be prioritizing strategies that will reduce your taxable income in the future! You will most assuredly face fewer deductions, fewer benefits, higher taxes and a weak dollar; therefore, reducing your taxable income in the future will be the biggest and most important aspect of your plan to efficiently climb down the mountain and make it out alive. The only factor that determines success is the reaction of the government. Shouldn’t we be studying them and NOT the financial products? All other discussions are only focused on making it to the summit. Our clients come to know what it means to have a plan for distribution and how their plan will ensure that they will NEVER be poor. Our job isn’t to help you strike it rich. Our job is to secure that you not only summit the mountain but that you make it down safely regardless of the conditions or challenges you face.

So, I ask you, why did the chicken cross the road? My answer, because she knew she could make it.

What other factors point to the thought that this may be the lowest tax bracket you will ever be in (what we call Defining Moment #2)?

The continual decline in the overall labor force will pose a huge problem. We already know that from a percentage standpoint, there will be fewer taxpaying workers than there are retirees who are and will be on government programs. And they will be living longer. Watch for my Demographics blog (next week). This is a serious issue that virtually no financial planner is discussing with their client.

So let’s take a look at this: we have a declining workforce in the United States, we have an aging population living longer on government programs, we have a government that’s spending like it’s on crack, and we have $50+ trillion in future government financial burdens. Unfortunately the only source of revenue for the Federal Government comes from you, in the form of taxes.

From the government’s standpoint, do you think they are going to lower taxes or raise taxes? Decrease or increase government benefits? You may start to put a few things together about your qualified plans here and why the government is highly motivated to stay in charge of them.

Afterall, who owns the pen on those accounts? Who’s your partner? The government. They control it all. When you open your statement on your 401k how much of it is yours? You have no idea. Why do you have no idea? Your plan is taxed at the tax rate you qualify for when you begin to withdraw funds. What’s that rate? No one knows. Do you think the government may be in need in the near future? Do you think they may need to raise taxes? You must start putting this together folks.

Ever thought why they made some changes recently to IRAs? Was it really for our benefit? Could they raid investment accounts? Of course they can. That’s why they created these things in the first place…another lesson on Demographics. You must understand when Qualified Plans were created and why – Demographics blog next week will address this issue.

Imagine now, if you can, your future savings and retirement money being taxed at two times today’s levels. Once again this is an estimate from the government’s GAO. Traditional thinkers and the so called experts from the government –please key in on from where they are experts–are now telling us that in order to survive in the future, where we will all be living longer, we must save more money now…and specifically into these types of accounts where they control the rules.

Upsetting isn’t it? “Save more now so we can control it later.” This is why this one bugs us so much.

If given a choice would you want to receive money now, when taxes are the lowest, or later when taxes may be much higher? If you are successful and are saving money and deferring the taxes to a later date, you may want to rethink the dilemna awaiting for you. The old adage “You will probably retire to two-thirds of your income thus be in a lower tax bracket” may be floating around in your mind.

But THINK about that for a minute! What determines your tax bracket? Your income. So, your planner is telling you to work your whole life, save, put it at risk so you can lower your income to a smaller tax bracket when you finally retire?

Sorry, but I’ve yet to meet a client who plans on drastically reducing their lifestyle at retirement. The typically plan to maintain their lifestlye. For one, they now can travel, play more golf, and spend time with hobbies.

If anything, you have MORE expenses NOT less. This concept is pure foolish on it’s face but absurd when you take this Defining Moment to heart. There’s one sure-fire way to accomplish what this advice states and that is to lose most of your savings and investments. Tell you what, that’s easy to accomplish. If that’s your planner’s strategy, fire them.

So finally, do you really want to retire to the least amount of money so you are in the lowest tax bracket or do you want to maintain your current lifestyle? Maybe even retire to the MOST amount of money…but you can’t say that in today’s world can you.

How then, in an increasing tax environment, certain demographic changes, and a desire to not have the least amount of money in retirement, does this way of thinking still permeate most plans?

If it’s your plan, you need a good dose of Financial Caffeine and we’re just the guys to serve it to you.

We hear every day, “I thought that I should pay extra principle to lower my interest expense?”

First, the banks are in a win-win situation no matter what you do. You see, if you don’t make additional payments because you understand that you are giving the bank control of more money, then they will just collect more interest over time.

If you do make additional payments the bank doesn’t just sit on it. Remember, they’ve mastered Defining Moment #1 and the velocity of money. That additional money from you is used and lent back out to start the process all over again.

What would you rather do, follow traditional planning and make all attempts to have your $10 earn $1 more? Keep in mind, you have to deal with all the other flexible factors that we discuss in our Why Traditional Planning Fails To Reach Its Goals (future posts). Or, function more like a bank and have your $10 do the work of $50?

Yeah, I think the bank model works quite well. So what do we do? Well, here’s an important question: do you believe banks have your best interests at heart? Most people say no. If you said “no”, then have you ever asked yourself why banks offer a lower rate on a 15 year mortgage than a 30 year? If they don’t have your best interest at heart and they are giving you an incentive to go with a particular product, then maybe we should do a little math.

They understand perfectly AND IMPLEMENT the Defining Moment that money will never be worth more than it is today? They want as much of your money as soon as possible (ie a 15 year mortgage) in order to keep it moving, working, and earning for them.

They’ll even entice us by offering gifts for our deposits and they promote like crazy just how convenient it is to deposit our money. You’ve seen the recent TVcommercials about the new technology for ATM deposits. Isn’t it ironic that they also make us rely on credit scores which are a directly determined by just how quickly we pay them back?

If we apply this defining moment to our everyday lives the lesson becomes more and more apparent. By taking a look at the country’s savings rate, there’s no doubt that our ability to hang on to today’s money, the money that has the most buying power, is dwindling.

In reality more of our dollars are going to someone else in the form of debt payments, taxes, and other financial transfers more than it’s working for us. The ability for Americans to save “today’s” dollars has all but diminished.

The traditional approach must change, and the sooner the better. What is really needed is more financial literacy. It is so important to understand that “your money will never be worth more than it is today.” And equally important, how it may impact your thought process in your everyday life.

If you do, then maybe you’ll question the various strategies recommended to give your money as soon as possible to other entities. Even if it means incurring some more interest expense.

Do you remember the scene in the movie “Miracle” about the 1980 Olympic Hockey Team when coach Herb Brooks told the young men that today was NOT going to be the day that the Russian team would win? It was a defining moment for that team. Well, we talk about financial Defining Moments.

I don’t care how successful you are, if you do not understand how these financial Defining Moments effect you as you accumulate, preserve, and certainly as you distribute your wealth…well, then today they’ll probably beat you.

Defining Moment #1 is, “your money will never be worth more than it is today.” That sounds really simple and if you think about it, you’ll agree that EVERY financial institution masters this one lesson. Because of this, they also understand the phrase “the velocity of money.”

Money that doesn’t move or have velocity is like money that is stuffed in a mattress; it doesn’t create wealth or profits. To give you an example, the average bank in the United States spends a dollar about five and a half times. Have you ever thought how they do that?

Wouldn’t you love to spend YOUR dollar 5 ½ times? Well, it’s simple. First they TOTALLY embrace this Defining Moment. You see, they take money, and it is not even their money, that is deposited in their bank and lend it to other people.

These people who borrowed the money make payments back to the bank and pay interest. The bank then takes those monthly payments and lends that money out again, over and over. This process continues repetitively about five times on each dollar they touch.

The collection of interest alone is very profitable for the bank. But they understand one rule that creates more profit for them than just collecting interest. They understand that MONEY WILL NEVER BE WORTH MORE THAN IT IS TODAY.

Due to inflation the buying power of a dollar decreases over time. The buying power of $1,000 today with a 3% inflation factor built in will have the buying power of only $412 in 30 years. The banks and lending institutions understand this clearly and they may even encourage you to make additional monthly payments on the money they lent you.

Wait a minute Kelly, I thought that I should pay extra to lower my interest expense?

Well, if you understand and, more importantly, apply Defining Moment #1, then maybe you should ask some questions.

A modified what? It’s called a Modified Endowment Contract (MEC) and was a creation of the terrible twins TAMRA (Technical And Miscellaneous Revenue Act of 1988) and DEFRA (Deficit Reduction Act of 1984).

It’s important you understand why the MEC was created, who created it, and how it can effect your money. IRS Code, Title 26, Subtitle F, Chapter 79, Section 7720 is the description. If you’re bored feel free to read it. Here’s the point. The very fact they, the government, made the effort to craft and pass this type of restriction and limitation on what you could do with your money, keep in mind, it wasn’t like this prior to 1988, tells us one thing: it must be good in regards to taxation.

You see, prior to 1988 you could put virtually an unlimited amount of money into cash value life insurance and get all the benefits. What benefits? Here’s a list:

money grows tax deferred,

can be used tax free,

has a competitve rate-of-return (remember no fees and no tax),

has guarantees,

returns a tax-free dividend based upon company performance,

the money is credit proof,

you could contribute an unlimited amount of money,

you were unlimited in your investment options because you had

liquidity, use and control of the money,

it could be used as collateral,

it was estate tax-free, and

had disability protection – meaning if you became disabled the insurance company would continue to contribute your annual outlay (what 401k will do that one?).

Take a look at this pdf and line up the benefits you have with your money compared to how these policies are designed…click here.

The government didn’t like this; therefore, they decided to “further limit the perceived abuses by preventing policyholders from paying large single premiums to purchase life insurance and borrowing the cash value, tax-free.” Heaven forbid we have some financial tools that they don’t have their hands ALL over. The founding fathers of this country would be up-in-arms. Folks, this type of policy, and the benefits associated with it, had been a LONG standing tool used by virtually all the wealthy families in the country…here’s a great book that describes this very thing, The Pirates of Manhattan. I have no association with this book it’s just a good read. Check this out, this is an article from November of 1999 in the Denver Business Journal. They did a special publication called The Century Book. This publication dedicated one page for every year from 1900 to 1999 and covered something from Denver’s history for each year. For the 1929 page they talked about the Crash and introduced you to Claude Boettcher – “Denver’s most famous investor”. Anyone who has lived in Colorado for any length of time has heard of the Boettcher family. This article mentions how he lost everything but waited for banks and stocks to drop so low that he borrowed $2,000,000 from his cash value life insurance to buy them all up (notice he lost his investments but he didn’t lose his insurance values). I love the line right after the mention of this – “the reason he is still known to history. Most investors had no other resources to call on.” Read it here. The “Infinite Banking Concept” is NOT NEW! It has been around for over a century.

In 1988, the government created a limit. So think about this: who determines the minimum one can pay for a death benefit of, let’s say $500,000? Come on, who determines the minimum you, the consumer, can pay for a death benefit of half a million? The insurance company. They decide what they can charge you and still make a profit. This is called term insurance. You pay the least amount and get one benefit – death benefit. On the other side of the spectrum, who determines the MOST you can pay for that same $500,000 death benefit? Most people say, “I do. I determine the most I’m willing to pay.” Wrong. The government. The very fact that the government limits what you are able to do with your money tells you that it must be good in regards to taxes. You know what, they’re right. Of course they’re right. Taxes are their biggest concern. If they aren’t getting them then you bet your $SS they’ll go out and find them.

It then begs the question as to why whole life insurance policies are still around then, right? Well, you can still get all the above benefits, EVERY one of them, you just have to now capitalize the policy a little slower. Before 1988, you could put, for example, $200,000 as a lump sum into a policy and get all the benefits. Today, you have to spread that out over, typically, a five to seven year period. The argument of “cash value life insurance is too expensive” is plain elementary. Those supposed experts who make that claim are right if someone is using CVLI purely for protection…i.e., focused on one benefit. Buy term and do something with the rest. However, if you want to act and function just like a bank then you’d pay the most amount of money for the smallest death benefit to dance just below the MEC line and get ALL the benefits above on your money. Read that sentence again. Around year five you’d have available every single dollar you put in. This then becomes a pool of money that you can use to replace any financing or lost opportunity for paying cash. It’s exactly what banks do. Take a look at this graph (it’s nothing fancy as I created it, but the data is straight from the FDIC website). I broke down the top five banks and their holdings in cash value life insurance, in the BILLIONS, and more importantly, how they have increased their holdings over the past few years.

JPMorgan Chase is the only one who’s values went down between 2008 and 2009; however, their loan balances went up by almost the exact same amount. They very well likely utilized this powerful tool to borrow from. We’ll know at the end of this year when we see their numbers. Folks, these are the top five banks in the country making double digit percentage increases in their cash value holdings! Why? Because they are masters of liquidity, use and control, and leverage. I ask you, are you?